We maintain the TP at HK$29.20 and the investment rating as "Buy". Considering strong demand in the server and storage market brought about by strong demand for computing power of artificial intelligence （AI）， as well as ZTE's （the "Company"） in-depth expansion in various fields of the second curve business, we maintain the TP at HK$29.20 and the investment rating as "Buy". The TP represents 12.5x/ 10.7x/ 9.2x 2023-2025 PER.
ZTE's 1QFY23 results were in line with our expectations. According to PRC Accounting Standards for Business Enterprises （ASBEs）， operating revenue in 1QFY23 increased by 4.3% yoy to RMB29,143 million. The gross profit margin of the Company increased by 6.7 ppt yoy to 44.5%. Shareholders' net profit increased by 19.2% yoy, while shareholders' net profit after extraordinary items increased by 25.7% yoy. R&D expenses to total revenue increased by 3.5 ppt yoy to 20.4%. We believe that strong R&D investment will ensure the Company's leading-edge advantage in the ICT technology and equipment market. Under the background of new infrastructure, the "eastern data and western computing" initiative, as well as carbon peaking and carbon neutrality, the Company is rapidly expanding its different business areas in the second curve; revenue in the second curve increased by over 40% yoy in 1Q23. The Company is deeply involved in areas of server, switch, distributed database, digital energy, cloud computer, etc. Among these, for database, the Company ranked number one in domestic distributed databases for the finance industry and this business began to operate as a subsidiary in 2022; in terms of data center, the Company gradually increases the proportion of self-developed data center products; in the computing power area, the Company's second curve business has gradually transferred from the communication technology （CT） field to the ICT field, covering the overall solutions of Iaas, Saas, Paas. In addition, demand from the domestic digital energy market has increased; in 2022 the Company ranked first in two tenders for China Tower integrated power supply and large-scale power supply, and we expect that in 2023 the Company will continue to expand business scale of digital energy.
We expect development of ZTE's server and storage business to exceed market expectations. In 2022, the global server market size was over US$100 billion, and China server market size was about RMB180 billion; China server market size is expected to grow at a CAGR of about 9% in the next five years. The Company released the G5 server at the beginning of 2023, accelerating the construction of data centers and the procurement of servers. The Company's server sales are expected to maintain rapid growth in 2023. In addition, the Company will launch GPU servers supporting large bandwidth ChatGPT by the end of 2023, and previously the Company announced that their servers will support Baidu's ERNIE Bot. We expect the massive demand for AI computing power to create a huge market opportunity for the Company's server business.
Catalysts: Quicker-than-expected growth within different business areas in the second curve; acceleration of gigabit optical network.
Risks: Risk of Sino-US trade friction; weaker-than-expected demand from government and corporate customers.